The Internal Revenue Service has issued a series of questions and answers regarding the CARES Act coronavirus-related relief for retirement plans and Individual Retirement Accounts. That’s helpful as folks consider tapping these accounts in the economic downturn.

As of April 17, Fidelity Investments found that 164,950 individuals (nearly 1 out of 100) covered under 401(k) and 403(b) workplace retirement plans that it administers already had taken a CARES distribution. Of those, 3,256 had requested the maximum $100,000 distribution.

The CARES Act, the $2 trillion stimulus package passed in late March, opened the door to taking huge sums out of retirement accounts. That raises a lot of questions.

Who’s eligible? The IRS FAQ says that they’ve received and are reviewing comments requesting that the list of eligibility factors be expanded. For now, it’s clear that you automatically qualify if you, a spouse or dependent tested positive for COVID-19 or if you’ve been impacted more broadly. You also qualify if you’ve experienced “adverse financial consequences” on account of being quarantined, being furloughed or laid off or having work hours reduced, being unable to work due to lack of child care or the closing or reduction in hours of a business you own and operate. The FAQ stress that an individual is entitled to treat a distribution as a coronavirus-related distribution for income tax purposes “only if the individual actually meets the eligibility requirements.”

Under the new law, you can take up to $100,000 as a distribution in calendar year 2020, and the normal 10% early withdrawal penalty for folks under 59 1/2 is waived. The FAQ clarifies that the $100,000 is an aggregate limit for all plans (you can’t take $100,000 out of a 401(k) and another $10,000 out of an IRA). You’ll still owe income taxes on the money you take out, but you’re allowed three years to pay the taxes.

The FAQs include this example: “If you receive a $9,000 coronavirus-related distribution in 2020, you would report $3,000 in income on your federal income tax return for each of 2020, 2021, and 2022. However, you have the option of including the entire distribution in your income for the year of the distribution.” The year of distribution option might make more sense if your income for that year is lower than what you expect it to be in future years.

If your circumstances improve, the new law says that you can redeposit the money you took out back into your retirement account (or another eligible retirement account) as a rollover contribution within three years. The IRS FAQ give an example of how this would work: If you receive a distribution in 2020 and choose to include it in income over three years (2020, 2021, and 2022), and then repay the full amount to an eligible retirement plan in 2022, you may file amended federal income tax returns for 2020 and 2021 to claim a refund of the tax attributable to the amount of the distribution that you included in income for those years, and you will not be required to include any amount in income in 2022.

Check with your employer plan administrator before you assume you’ll be able to redeposit money to replenish your nest egg. The IRS FAQs note that some employer retirement plans don’t allow rollover contributions, and that “a plan is not required to change its terms or procedures to accept repayments.”

The new law also increases the amount you can borrow from your 401(k). Through September 22, 2020, you can borrow 100% of your account balance up to $100,000 (less any outstanding loans). That’s up from the normal $50,000 limit. In addition, for outstanding loans, the due date for payments due through December 31, 2020 can be delayed up to one year. But the IRS FAQ notes that any payments after the suspension period will be adjusted to reflect the delay and any interest accrued during the delay.

Should you take a loan or a distribution? Alison Borland, an executive vice president at benefits provider Alight warns on PlanSponsor that the CARES Act provision allowing larger loans is sub-optimal when compared to the more flexible distribution option. Loans carry a greater risk. To start with, payments are high, so you might not be able to afford them. For example, a five-year loan of $100,000 at typical rates results in a payment of about $1,800 per month. “This math just doesn’t work for most participants and could lead to a wave of defaults in 2021,” she predicts. Worse, a defaulted COVID-19-related loan would incur full income taxation plus the 10% early withdrawal penalty in the year of default. With a distribution, by contrast, you have the three years to pay the income tax, and the 10% penalty is waived altogether.

What if your employer doesn’t adopt the COVID-19-related retirement provisions? According to the IRS FAQs, you can still take a distribution and treat it as a COVID-19 distribution when you file your income tax returns (Question 9).

The IRS FAQ says that more formal guidance will be forthcoming. In the meantime, it includes a link to the 16-page 2005 retirement plan relief guidance issued post-Hurricane Katrina, as the IRS expects the formal CARES Act guidance will apply the same rules. Also, there will be a new IRS form, Form 8915E, to report repayments of coronavirus distributions.

This article was written by Ashlea Ebeling from Forbes and was legally licensed by AdvisorStream through the NewsCred publisher network.

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